# Expected Utility Theory Expected Utility Theory (von Neumann & Morgenstern, 1944) is the standard economic model of rational decision-making under uncertainty. A rational agent chooses the option that maximizes expected utility: probability × utility, summed across outcomes. The theory assumes consistent preferences, transitivity, and independence of irrelevant alternatives. [[Daniel Kahneman]] and Tversky's [[Prospect Theory]] showed humans systematically violate EU theory: we're loss-averse, weight probabilities nonlinearly, and use reference points. EU theory remains normatively useful (how we *should* decide) while behavioral economics describes how we actually decide. Connects to [[Heuristics]], [[Cognitive Biases]], and [[Behavioral Economics]]. ## EU vs Prospect Theory | Expected Utility | Prospect Theory | |------------------|-----------------| | Linear probability | Probability weighting | | No reference point | Gains/losses from reference | | Risk-neutral | Loss aversion | ## References - von Neumann & Morgenstern. *Theory of Games and Economic Behavior* (1944) ## Related - [[Daniel Kahneman]] - [[Prospect Theory]] - [[Behavioral Economics]] - [[Decision Making]]